It's the big new thing in America, replacing the traditional pension ("defined benefit") plans people used to have. Everyone in the private sector seems to have one, so they must be a good thing. Right?
The cover story of the October 9, 2009 issue of Time was titled "Why it's time to retire the 401k." Here's some of what they had to say:
" Invented nearly 30 years ago as an executive perk — one more way to dodge Uncle Sam — the 401(k) was never meant to replace the employer-guaranteed pension fund, supplemented by Social Security, as the cornerstone of our nation's retirement system. But propelled by a combination of companies looking to cut costs and consumers who wanted control of their retirement destiny, that's exactly what happened."
"Congress was trying to close a loophole on executive bonuses when it created the 401(k). Most companies intended 401(k)s — which were originally called salary-reduction plans but then renamed for the portion of the tax code that makes them possible — to be a perk for highly paid executives, not a pension replacement. That's because lower-paid employees probably could not afford to defer a portion of their paychecks. So companies held on to their pension systems even as they added 401(k)s, which by law they had to make available to all employees. When the market took off in the 1980s, the rank and file clamored to get in....On the corporate end, a change in accounting rules made the growing cost of pensions more apparent to shareholders. Cutting the pension was a guaranteed way to improve the bottom line. The rise of the 401(k) began." [Emphasis mine.]"
In a defined benefit plan (traditional pension), you and your employer contribute money to a fund which is professionally managed and is responsible for paying you a monthly pension from the day you retire until the day you die. If you agree to take a slightly smaller monthly payment, you can even arrange for your benefit to continue for your spouse after your death. Managing the money to make this possible is the responsibility of the pension plan, not you.
In a defined contribution plan (401(k)), you--and perhaps your employer, but not always--contribute to a fund which you are responsible for managing. Whatever is there on the day you retire is what you have to live on for the rest of your life.
The NYS Teachers' Retirement System uses a recent study by the non-profit National Institute on Retirement Security (NIRS) to point out a fundamental flaw with defined contribution plans. Here is some of what they said:
"You may have seen or heard that public employee pensions are "too expensive" and should be replaced. The non-profit National Institute on Retirement Security (NIRS) is among the many groups that do not agree. Your defined benefit (DB) pension, NIRS argues, actually makes good fiscal sense for employers. "
"NIRS recently completed a series of studies designed to measure the cost and impact of DB plans throughout the country. For employers, the Washington, D.C.-based group concluded DB plans deliver better "bang for the buck" than Defined Contribution (DC) plans, such as 401(k) plans. According to the report, over the course of a member's working life, "the embedded economic efficiencies of DB plans make them nearly half the cost of DC plans."
"To prove the point, an example was cited of a 62-year-old with a target retirement benefit of $26,684. Under the DB plan, annual contributions of 12.5% of payroll would be required and $355,000 would need to be set aside by age 62. In contrast, the DC plan would require annual contributions of 22.9% of payroll and $550,000 would need to be set aside by age 62. As stated in the report, "The DB plan can do more with less, providing the same benefit for nearly $200,000 less per participant."
"Here's how: DC plans are individual focused and, in order to ensure she/he does not outlive retirement savings, the individual must save enough to live to a very old age — typically 95 to 100. By contrast, a DB plan pools the contributions of many people, with a goal of saving enough for an average life expectancy for each member of the plan. An average life expectancy, which actuaries calculate with a high degree of accuracy, is much lower than 95 to 100— meaning it is necessary to set aside significantly less per DB plan member." [Emphasis mine.]
Here is the link to this information on the NYSTRS website:
How, then, can the defined contribution plan claim to be "less costly" for the employer? The only way this happens is if there is no attempt to create a plan which will pay the same benefit as the traditional pension.
And that's what the American public has yet to discover. When they do figure it out, there will be hell to pay.
And that, as I've said before, is why we're fighting so damn hard to preserve the NYS Teachers' Retirement System as a defined benefit plan.
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